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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to             
Commission File Number: 001-36383
 
Five9, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
 
94- 3394123
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
Bishop Ranch 8
4000 Executive Parkway, Suite 400
San Ramon, CA 94583
(Address of Principal Executive Offices) (Zip Code)
(925) 201-2000
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes: x    No:  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes:  x    No:  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
o
 
 
Accelerated Filer
x
Non-accelerated filer
o
(Do not check if a smaller reporting Company)
 
Smaller Reporting Company
o
 
 
 
 
Emerging Growth Company
x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    Yes: x    No:  o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes:  o  No:  x
As of November 1, 2017, there were 55,650,970 shares of the Registrant’s common stock, par value $0.001 per share, outstanding.


Table of Contents

FIVE9, INC.
FORM 10-Q
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, which involve substantial risks and uncertainties. These statements reflect the current views of our senior management with respect to future events and our financial performance. These forward-looking statements include statements with respect to our business, expenses, strategies, losses, growth plans, product and client initiatives, market growth projections, and our industry. Statements that include the words “expect,” “intend,” “plan,” “believe,” “project,” “forecast,” “estimate,” “may,” “should,” “anticipate” and similar statements of a future or forward-looking nature identify forward-looking statements for purposes of the federal securities laws or otherwise.
Forward-looking statements address matters that involve risks and uncertainties. Accordingly, there are or will be important factors that could cause our actual results to differ materially from those indicated in these statements. These factors include the information set forth under the caption “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q, including the following:
our quarterly and annual results may fluctuate significantly, may not fully reflect the underlying performance of our business and may result in decreases in the price of our common stock;
if we are unable to attract new clients or sell additional services and functionality to our existing clients, our revenue and revenue growth will be harmed;
our recent rapid growth may not be indicative of our future growth, and even if we continue to grow rapidly, we may fail to manage our growth effectively;
failure to adequately expand our sales force could impede our growth;
if we fail to manage our technical operations infrastructure, our existing clients may experience service outages, our new clients may experience delays in the deployment of our solution and we could be subject to, among other things, claims for credits or damages;
security breaches and improper access to or disclosure of our data or our clients’ data or other cyber attacks on our systems, could result in litigation and regulatory risk, harm our reputation and adversely affect our business;
the markets in which we participate are highly competitive, and if we do not compete effectively, our operating results could be harmed;
if our existing clients terminate their subscriptions or reduce their subscriptions and related usage, our revenues and gross margins will be harmed and we will be required to spend more money to grow our client base;
our growth depends in part on the success of our strategic relationships with third parties and our failure to successfully grow and manage these relationships could harm our business;
we are establishing a network of master agents and resellers to sell our solution; our failure to effectively develop, manage, and maintain this network could materially harm our revenues;
we sell our solution to larger organizations that require longer sales and implementation cycles and often demand more configuration and integration services or customized features and functions that we may not offer, any of which could delay or prevent these sales and harm our growth rates, business and operating results;
because a significant percentage of our revenue is derived from existing clients, downturns or upturns in new sales will not be immediately reflected in our operating results and may be difficult to discern;
we rely on third-party telecommunications and internet service providers to provide our clients and their customers with telecommunication services and connectivity to our cloud contact center software and any failure by these service providers to provide reliable services could subject us to, among other things, claims for credits or damages;
we have a history of losses and we may be unable to achieve or sustain profitability;
we may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs; and
failure to comply with laws and regulations could harm our business and our reputation.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Quarterly Report on Form 10-Q. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, our actual results may differ

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materially from what we anticipate. You should not place undue reliance on our forward-looking statements. Any forward-looking statements you read in this Quarterly Report on Form 10-Q reflect our views only as of the date of this report with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law.


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PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIVE9, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
 
September 30, 2017
 
December 31, 2016
 
 
(Unaudited)
 
 
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
63,364

 
$
58,122

Accounts receivable, net
 
17,231

 
13,881

Prepaid expenses and other current assets
 
4,809

 
3,008

Total current assets
 
85,404

 
75,011

Property and equipment, net
 
17,958

 
14,688

Intangible assets, net
 
1,190

 
1,539

Goodwill
 
11,798

 
11,798

Other assets
 
2,365

 
2,203

Total assets
 
$
118,715

 
$
105,239

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
4,787

 
$
3,366

Accrued and other current liabilities
 
11,967

 
9,604

Accrued federal fees
 
1,146

 
2,742

Sales tax liability
 
1,174

 
1,347

Notes payable
 
486

 
742

Capital leases
 
6,057

 
6,230

Deferred revenue
 
13,699

 
10,047

Total current liabilities
 
39,316

 
34,078

Revolving line of credit
 
32,594

 
32,594

Sales tax liability — less current portion
 
1,207

 
1,476

Notes payable — less current portion
 

 
318

Capital leases — less current portion
 
6,867

 
5,915

Other long-term liabilities
 
959

 
530

Total liabilities
 
80,943

 
74,911

Commitments and contingencies (Note 9)
 

 

Stockholders’ equity:
 
 
 
 
Preferred stock, $0.001 par value; 5,000 shares authorized, no shares issued and outstanding at September 30, 2017 and December 31, 2016
 

 

Common stock, $0.001 par value; 450,000 shares authorized, 55,631 shares and 53,363 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively
 
56

 
53

Additional paid-in capital
 
212,505

 
196,555

Accumulated deficit
 
(174,789
)
 
(166,280
)
Total stockholders’ equity
 
37,772

 
30,328

Total liabilities and stockholders’ equity
 
$
118,715

 
$
105,239

See accompanying notes to condensed consolidated financial statements.

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FIVE9, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Unaudited, in thousands, except per share data)

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Revenue
 
$
50,081

 
$
40,982

 
$
144,822

 
$
117,883

Cost of revenue
 
20,497

 
17,790

 
60,741

 
51,164

Gross profit
 
29,584

 
23,192

 
84,081

 
66,719

Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
6,689

 
6,041

 
20,372

 
17,642

Sales and marketing
 
16,502

 
12,925

 
49,212

 
38,268

General and administrative
 
4,679

 
6,143

 
20,384

 
18,561

Total operating expenses
 
27,870

 
25,109

 
89,968

 
74,471

Income (loss) from operations
 
1,714

 
(1,917
)
 
(5,887
)
 
(7,752
)
Other income (expense), net:
 
 
 
 
 
 
 
 
Extinguishment of debt
 

 
(1,026
)
 

 
(1,026
)
Interest expense
 
(865
)
 
(961
)
 
(2,635
)
 
(3,357
)
Interest income and other
 
118

 
12

 
326

 
(66
)
Total other expense, net
 
(747
)
 
(1,975
)
 
(2,309
)
 
(4,449
)
Income (loss) before income taxes
 
967

 
(3,892
)
 
(8,196
)
 
(12,201
)
Provision for (benefit from) income taxes
 
43

 
(2
)
 
142

 
68

Net income (loss)
 
$
924

 
$
(3,890
)
 
$
(8,338
)
 
$
(12,269
)
Net income (loss) per share:
 
 
 
 
 
 
 
 
Basic
 
$
0.02

 
$
(0.07
)
 
$
(0.15
)
 
$
(0.24
)
Diluted

$
0.02


$
(0.07
)

$
(0.15
)

$
(0.24
)
Shares used in computing net income (loss) per share:
 
 
 
 
 
 
 
 
Basic
 
55,310

 
52,708

 
54,579

 
52,078

Diluted
 
59,441


52,708


54,579


52,078

Comprehensive Income (Loss):
 
 
 
 
 
 
 
 
Net income (loss) and comprehensive income (loss)
 
$
924

 
$
(3,890
)
 
$
(8,338
)
 
$
(12,269
)
See accompanying notes to condensed consolidated financial statements.

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FIVE9, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
 
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(8,338
)
 
$
(12,269
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
6,246

 
6,302

Provision for doubtful accounts
 
66

 
58

Stock-based compensation
 
10,703

 
6,927

Loss on extinguishment of debt
 

 
1,026

Reversal of interest and penalties on accrued federal fees
 
(2,133
)
 

Non-cash adjustment on investment
 
(233
)
 

Amortization of debt discount and issuance costs
 
60

 
221

Accretion of interest
 
16

 
11

Others
 
(50
)
 
(9
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
(3,406
)
 
(2,383
)
Prepaid expenses and other current assets
 
(1,861
)
 
(1,927
)
Other assets
 
71

 
(25
)
Accounts payable
 
1,409

 
1,039

Accrued and other current liabilities
 
1,774

 
2,749

Accrued federal fees and sales tax liability
 
95

 
(90
)
Deferred revenue
 
3,676

 
2,449

Other liabilities
 
131

 
(75
)
Net cash provided by operating activities
 
8,226

 
4,004

Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(1,809
)
 
(973
)
Increase in restricted cash
 

 
(60
)
Net cash used in investing activities
 
(1,809
)
 
(1,033
)
Cash flows from financing activities:
 
 
 
 
Proceeds from exercise of common stock options
 
3,280

 
4,050

Proceeds from sale of common stock under ESPP
 
1,800

 
792

Proceeds from revolving line of credit
 

 
32,594

Repayments on revolving line of credit
 

 
(12,500
)
Repayments of notes payable
 
(547
)
 
(23,866
)
Payments of capital leases
 
(5,708
)
 
(4,618
)
Payment of prepayment penalty and related fees
 

 
(368
)
Payments for debt issuance costs
 

 
(206
)
Net cash used in financing activities
 
(1,175
)
 
(4,122
)
Net increase (decrease) in cash and cash equivalents
 
5,242

 
(1,151
)
Cash and cash equivalents:
 
 
 
 
Beginning of period
 
58,122

 
58,484

End of period
 
$
63,364

 
$
57,333


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Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
Supplemental disclosures of cash flow data:
 
 
 
 
Cash paid for interest
 
$
2,588

 
$
3,430

Cash paid for income taxes
 
113

 
86

Non-cash investing and financing activities:
 
 
 
 
Equipment obtained under capital lease
 
$
7,482

 
$
5,548

Equipment purchased and unpaid at period-end
 
22

 
13

See accompanying notes to condensed consolidated financial statements.


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FIVE9, INC.
Notes to Condensed Consolidated Financial Statements (Unaudited)
1. Description of Business and Summary of Significant Accounting Policies
Five9, Inc. and its wholly-owned subsidiaries (the “Company”) is a provider of cloud software for contact centers. The Company was incorporated in Delaware in 2001 and is headquartered in San Ramon, California. The Company has offices in Europe and Asia, which primarily provide research, development, sales, marketing, and client support services.
Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. In the opinion of management, the condensed consolidated financial statements reflect all adjustments, which are normal and recurring in nature, necessary for fair financial statement presentation. All intercompany transactions and balances have been eliminated in consolidation.
Certain prior period amounts included in the condensed consolidated financial statements have been reclassified to conform to the current period presentation.
Use of Estimates
The preparation of condensed consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The significant estimates made by management affect revenue, the allowance for doubtful accounts, intangible assets, goodwill, loss contingencies, including the Company’s accrual for federal fees and sales tax liability, accrued liabilities, stock-based compensation, provision for income taxes and uncertain tax positions. Management periodically evaluates such estimates and they are adjusted prospectively based upon such periodic evaluation. Actual results could differ from those estimates.
Significant Accounting Policies
The Company’s significant accounting policies are disclosed in its Annual Report on Form 10-K for the year ended December 31, 2016. During the nine months ended September 30, 2017, there were no significant changes to the Company's significant accounting policies.
Recently Adopted Accounting Pronouncements
In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This ASU simplifies several aspects of the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The guidance was effective for the Company beginning in the first quarter of 2017. Accordingly, commencing in January 2017, the Company accounted for forfeitures as they occurred, rather than by estimating expected forfeitures. The net effect of this change was recognized as a $0.2 million reduction to accumulated deficit in the condensed consolidated financial statements. Upon adoption of the new standard, all excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) are recognized as income tax expense or benefit in the income statement. The tax effects of exercised or vested awards are treated as discrete items in the reporting period in which they occur. The Company also recognizes excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. The Company has applied the modified retrospective adoption approach beginning January 1, 2017 and prior periods have not been adjusted. As a result, the Company established a net operating loss deferred tax asset of $5.3 million to account for prior period excess tax benefits through retained earnings, however an offsetting valuation allowance of $5.3 million was also established through retained earnings because it is not more likely than not that

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the deferred tax asset will be realized due to historical and expected future losses, such that there is no impact on the Company’s condensed consolidated financial statements.
Recent Accounting Pronouncements Not Yet Effective
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires measurement and recognition of expected credit losses for certain types of financial assets held. ASU 2016-13 is effective for the Company in its first quarter of 2020, and earlier adoption is permitted beginning in the first quarter of 2019. The Company is currently evaluating the impact of ASU 2016-13 on its consolidated financial statements.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). Under the new guidance, a lessee will be required to recognize assets and liabilities for both finance, or capital, and operating leases with lease terms of more than 12 months. The ASU also will require disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. Lessor accounting will remain largely unchanged from current GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach that includes a number of optional practical expedients that entities may elect to apply. This guidance is effective for the Company beginning in the first quarter of 2019. Early adoption is permitted. The Company is currently assessing the effect the guidance will have on its consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers: Topic 606 and issued subsequent amendments to the initial guidance in August 2015, March 2016, April 2016 and May 2016 within ASU 2015-04, ASU 2016-08, ASU 2016-10 and ASU 2016-12, respectively (ASU 2014-09, ASU 2015-04, ASU 2016-08, ASU 2016-10 and ASU 2016-12 collectively, Topic 606). Topic 606 requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers and will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. Topic 606 defines a five-step process to achieve this core principle and, in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP. Topic 606 is effective for the Company's annual and interim reporting periods beginning January 1, 2018 using either a retrospective or a cumulative effect transition method. The Company has developed an implementation plan to adopt this new guidance based on the cumulative effect transition method. As part of this plan, the Company is currently assessing the impact of the new guidance on its results of operations. Based on procedures performed to date, the Company does not believe the adoption of Topic 606 will have a material impact on the timing of revenue, but the adoption will have a material impact on commission expense. The Company will continue to evaluate this assessment in 2017. The Company intends to adopt Topic 606 on January 1, 2018.
2. Fair Value Measurements
The Company carries cash equivalents consisting of money market funds at fair value on a recurring basis. Fair value is based on the price that would be received from selling an asset in an orderly transaction between market participants at the measurement date. Fair value is estimated by applying the following hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:
Level 1 — Observable inputs which include unadjusted quoted prices in active markets for identical assets.
Level 2 — Observable inputs other than Level 1 inputs, such as quoted prices for similar assets, quoted prices for identical or similar assets in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset.
Level 3 — Unobservable inputs that are supported by little or no market activity and that are based on management’s assumptions, including fair value measurements determined by using pricing models, discounted cash flow methodologies or similar techniques.

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The fair value of assets carried at fair value was determined using the following inputs (in thousands):
 
 
September 30, 2017
 
 
Total
 
Level 1
Level 3
Assets
 
 
 
 
 
Cash equivalents
 
 
 
 
 
Money market funds
 
$
20,060

 
$
20,060

$

Other Assets
 
 
 
 
 
Embedded conversion option held for investment
 
$
946

 
$

$
946

 
 
 
 
 
 
 
 
December 31, 2016
 
 
Total
 
Level 1
Level 3
Assets
 
 
 
 
 
Cash equivalents
 
 
 
 
 
Money market funds
 
$
20,069

 
$
20,069

$

Other Assets
 
 
 
 
 
Embedded conversion option held for investment
 
$
873

 
$

$
873

 
 
 
 
 
 

Fair Value Measured and Recorded Using Significant Unobservable Inputs (Level 3) (in thousands):
 
September 30, 2017
Beginning balance
$
873

Total gains included in earnings
73

Ending balance
$
946

The valuation of an embedded conversion option held for investment with a convertible note was performed using a Black-Scholes option-pricing model which relies primarily on estimates of expected term, volatility, risk-free rate, and dividends related to our investment in a privately-held company, or the investee. The most significant unobservable inputs used in the determination of estimated fair value of the option are the estimates of share price and volatility, driven by the investee's ability to meet financial targets, and which directly correlates to the fair value recognized in other non-current assets within the condensed consolidated balance sheets.
The fair value of this asset is estimated quarterly by management based on inputs received from the investee's management using the excess earnings method under the income approach. Potential valuation adjustments are made as the progress toward achieving financial targets becomes determinable, with the impact of such adjustments being recorded to 'Interest income and other' in our condensed consolidated statements of operations and comprehensive loss.
During the nine months ended September 30, 2017, there were no transfers in or out of Level 3 from other levels in the fair value hierarchy.
There were no assets or liabilities measured at fair value on a non-recurring basis as of September 30, 2017.
3. Financial Statement Components
Cash and cash equivalents consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Cash
 
$
43,304

 
$
38,053

Money market funds
 
20,060

 
20,069

Cash and cash equivalents
 
$
63,364

 
$
58,122


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Accounts receivable, net consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Trade accounts receivable
 
$
16,096

 
$
12,640

Unbilled trade accounts receivable, net of advance client deposits
 
1,152

 
1,253

Allowance for doubtful accounts
 
(17
)
 
(12
)
Accounts receivable, net
 
$
17,231

 
$
13,881

Prepaid expenses and other current assets consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Prepaid expenses
 
$
3,034

 
$
2,199

Other current assets
 
1,775

 
809

Prepaid expenses and other current assets
 
$
4,809

 
$
3,008

Property and equipment, net consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Computer and network equipment
 
$
44,517

 
$
37,664

Computer software
 
6,383

 
5,133

Internal-use software development costs
 
500

 
475

Furniture and fixtures
 
1,223

 
1,130

Leasehold improvements
 
641

 
624

Property and equipment
 
53,264

 
45,026

Accumulated depreciation and amortization
 
(35,306
)
 
(30,338
)
Property and equipment, net
 
$
17,958

 
$
14,688

In accordance with our property and equipment policy, we review the estimated useful lives of our fixed assets on an ongoing basis. A review of our existing estimates indicated that the actual lives of certain data center assets were longer than previously estimated useful lives used for depreciation purposes in our financial statements. As a result, effective July 1, 2017, we changed the estimated useful lives of certain data center assets to better reflect the estimated periods during which these assets will remain in service. The estimated useful lives of these assets, which we previously depreciated for three years, have now been increased to a range of three to five years. This change in accounting estimate decreased depreciation expense by $0.8 million for the three and nine months ended September 30, 2017, increased both basic and diluted net income per share by $0.02 for the three months ended September 30, 2017, and decreased both basic and diluted net loss per share by $0.02 for the nine months ended September 30, 2017.
Depreciation and amortization expense associated with property and equipment was $1.8 million and $5.9 million for the three and nine months ended September 30, 2017, respectively, and $2.0 million and $5.9 million for the three and nine months ended September 30, 2016, respectively.
Property and equipment capitalized under capital lease obligations consist primarily of computer and network equipment and was as follows (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Gross
 
$
44,471

 
$
35,504

Less: accumulated depreciation and amortization
 
(29,072
)
 
(23,128
)
Total
 
$
15,399

 
$
12,376


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Accrued and other current liabilities consisted of the following (in thousands):
 
 
September 30,
2017
 
December 31,
2016
Accrued compensation and benefits
 
$
9,669

 
$
7,456

Accrued expenses
 
2,298

 
2,148

Accrued and other current liabilities
 
$
11,967

 
$
9,604

4. Intangible Assets
The components of intangible assets were as follows (in thousands):
 
 
September 30, 2017
 
December 31, 2016
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
Developed technology
 
$
2,460

 
$
(1,390
)
 
$
1,070

 
$
2,460

 
$
(1,126
)
 
$
1,334

Customer relationships
 
520

 
(411
)
 
109

 
520

 
(333
)
 
187

Domain names
 
50

 
(39
)
 
11

 
50

 
(32
)
 
18

Non-compete agreements
 
140

 
(140
)
 

 
140

 
(140
)
 

Total
 
$
3,170

 
$
(1,980
)
 
$
1,190

 
$
3,170

 
$
(1,631
)
 
$
1,539

Amortization expense related to intangible assets was $0.1 million and $0.3 million for the three and nine months ended September 30, 2017, respectively, and $0.1 million and $0.4 million for the three and nine months ended September 30, 2016, respectively.
As of September 30, 2017, the expected future amortization expense for intangible assets was as follows (in thousands):
Period
 
Expected Future Amortization Expense
2017
 
$
117

2018
 
442

2019
 
351

2020
 
280

Total
 
$
1,190

5. Debt
2016 Loan and Security Agreement
On August 1, 2016, or the Effective Date, the Company entered into a loan and security agreement, or the 2016 Loan and Security Agreement, with the lenders party thereto and City National Bank, as agent for such lenders. The 2016 Loan and Security Agreement provides for a revolving line of credit, or the New Revolving Credit Facility, of up to $50.0 million and matures on August 1, 2019. On the Effective Date, the Company borrowed $32.6 million under the 2016 Loan and Security Agreement. The proceeds were used to extinguish existing indebtedness under all prior Loan and Security Agreements and for working capital and other general corporate purposes.
Loans under the 2016 Loan and Security Agreement bear a variable annual interest rate of the prime rate plus 0.50%, subject to a 0.25% increase if the Company's adjusted EBITDA is negative at the end of any fiscal quarter. The Company has agreed to pay a fee of 0.25% per annum on the unused portion of the New Revolving Credit Facility as well as an anniversary fee of $31,250 on each of the first and second anniversaries of the Effective Date. The Company is accreting the total estimation of unused fees and anniversary fees evenly over the full term of the 2016 Loan and Security Agreement. Under the terms of the 2016 Loan and Security Agreement, the outstanding balance cannot exceed the Company’s trailing four months of MRR (monthly recurring revenue including subscription and usage) multiplied by the average trailing 12 month dollar based retention rate (calculated on the same basis as in the Company’s periodic reports filed with the SEC). As of September 30, 2017, the outstanding

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principal balance under the 2016 Loan and Security Agreement was $32.6 million, which is included in 'Revolving line of credit' in the condensed consolidated balance sheets. As of September 30, 2017, the amount available for additional borrowings was $17.4 million.
The Company incurred approximately $0.2 million in fees that were directly attributable to the issuance of this credit facility. These costs are deferred and included within 'Prepaid expenses and other current assets' and 'Other assets' in the Company's condensed consolidated balance sheets and being amortized to interest expense on a straight-line basis over three years starting from the Effective Date of the New Revolving Credit Facility.
The obligations of the Company under the 2016 Loan and Security Agreement are guaranteed by the Company’s subsidiary, Five9 Acquisition. The Company’s obligations under the 2016 Loan and Security Agreement and Five9 Acquisition’s obligations under its guaranty are secured by a first priority perfected security interest in and lien on substantially all of the Company’s and Five9 Acquisition's assets. The 2016 Loan and Security Agreement contains certain customary covenants, including the requirement that the Company maintain $25.0 million of unrestricted cash deposited with the lenders for the term of the agreement, a minimum liquidity ratio of unrestricted cash and accounts receivable to the outstanding amounts under the 2016 Loan and Security Agreement, as well as customary events of default. Under the 2016 Loan and Security Agreement, the Company is also prohibited from declaring dividends or making other distributions on capital stock. The Company was in compliance with these covenants as of September 30, 2017.
The Company recorded a $1.0 million loss on extinguishment of debt in the third quarter of 2016 under the 2013 Loan and Security Agreement and the 2014 Loan and Security Agreement (each as described below). The loss was comprised of $0.4 million in prepayment penalties, a $0.4 million write-off of unamortized debt discounts, and a $0.2 million write-off of unamortized debt issuance costs.
2013 Loan and Security Agreement
Prior to entering into the 2016 Loan and Security Agreement on August 1, 2016, the Company had a revolving line of credit of up to $20.0 million, or the Prior Revolving Credit Facility, under a loan and security agreement with a lender, which was entered into in March 2013 and last amended in December 2014, or the 2013 Loan and Security Agreement. The Prior Revolving Credit Facility carried a variable annual interest rate of the prime rate plus 0.50% and would have matured on December 1, 2016.
The 2013 Loan and Security Agreement was collateralized by substantially all the assets of the Company. The balance outstanding could not exceed the lesser of (i) $20.0 million or (ii) an amount equal to the Company’s monthly recurring revenue for the three months prior multiplied by the average Dollar-Based Retention Rate over the prior twelve months, less the amount accrued for the Company’s Universal Service Fund (“USF”) obligation (accrued federal fees). As of August 1, 2016, the Company had canceled and paid back all amounts due under the Prior Revolving Credit Facility.
In connection with its acquisition of SoCoCare in October 2013, the Company also borrowed $5.0 million under a term loan, or the Term Loan, under the 2013 Loan and Security Agreement in October 2013. Monthly interest-only payments were due on the advance at the prime rate plus 1.50% through September 2014. Principal and interest payments were due in equal monthly installments from October 2014 through the maturity of the Term Loan in March 2017. As of August 1, 2016, the Company had canceled and paid back all amounts due under the Term Loan.
The 2013 Loan and Security Agreement contained certain covenants, including the requirement that the Company maintain $7.5 million of cash deposited with the lender for the term of the 2013 Loan and Security Agreement. The Company was in compliance with these covenants through the cancellation date of August 1, 2016. The 2013 Loan and Security Agreement remained senior to other debt, including the debt issued under the 2014 Loan and Security Agreement discussed below.
2014 Loan and Security Agreement
Prior to entering into the 2016 Loan and Security Agreement on August 1, 2016, the Company had a term loan facility of $30.0 million with a syndicate of two lenders, or Lenders, which was entered into in February 2014 and amended in December 2014 and February 2015, or the 2014 Loan and Security Agreement. The term loan facility was available to the Company in tranches. The first tranche for $20.0 million was advanced upon entering into the agreement. The remaining $10.0 million was available for drawdown by the Company until February 20, 2016 in $1.0 million increments, which expired on February 20, 2016. The Company incurred $0.4 million in debt costs in connection with borrowing the first tranche in February 2014. The term loan bore interest at a variable per annum

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rate equal to the greater of 10% or LIBOR plus 9%. Interest was due and payable on the last business day of each month during the term of the loan commencing in February 2014. Monthly principal payments were due beginning in February 2016 based on 1/60th of the outstanding balance at that time and would continue until all remaining principal outstanding under the term loan became due and payable in February 2019. As of August 1, 2016, the Company had canceled and paid back all borrowings under the 2014 Loan and Security Agreement.
The term loan was secured by substantially all the assets of the Company and was subordinate to the 2013 Loan and Security Agreement. The 2014 Loan and Security Agreement contained certain covenants and included the occurrence of a material adverse event, as defined in the agreement and determined by the Lenders, as an event of default. The Company was in compliance with these covenants through the effective cancellation date of August 1, 2016.
In connection with entering into the 2014 Loan and Security Agreement, the Company issued to the Lenders warrants to purchase 177,865 shares of common stock at $10.12 per share, which vest and become exercisable over a ten year term from the date of issuance, based on amounts drawn under the $30.0 million term loan facility. Based on the drawdown of $20.0 million in February 2014, 118,577 shares of common stock issuable under the warrants vested and are exercisable by the Lenders. The fair value of these vested warrants of $1.0 million was recorded as a discount against the debt proceeds and was being recognized as additional interest expense over the term of the loan. The remaining 59,288 shares of common stock issuable under the warrants pertaining to the undrawn $10.0 million did not vest and were no longer exercisable on February 20, 2016 when the $10.0 million was no longer available for borrowing.
Promissory Note
In July 2013, the Company issued a promissory note to the Universal Service Administrative Company, or USAC, for $4.1 million in principal amount as a financing arrangement for that amount of accrued federal fees. The promissory note carried a fixed annual interest rate of 12.75% and was repayable in 42 equal monthly installments of principal and interest beginning in August 2013. As of December 31, 2016, approximately $0.1 million of this promissory note was outstanding and is included as notes payable in the accompanying condensed consolidated balance sheets. This promissory note was fully paid as of January 2017.
FCC Civil Penalty
In June 2015, the Company entered into a consent decree with the Federal Communications Commission, or FCC, Enforcement Bureau, in which the Company agreed to pay a civil penalty of $2.0 million to the U.S. Treasury in twelve equal quarterly installments starting in July 2015 without interest. As a result, the Company discounted the $2.0 million liability, which was accrued in the third quarter of 2014 for the then tentative civil penalty, to its present value of $1.7 million at an annual interest rate of 12.75% to reflect the imputed interest and reclassified this discounted liability from 'Accrued federal fees' to 'Notes payable.' The $0.3 million discount was recorded as a reduction to general and administrative expense in the three months ended June 30, 2015 and is being recognized as interest expense over the payment term of the civil penalty. As of September 30, 2017 and December 31, 2016, the outstanding civil penalty payable was $0.5 million and $1.0 million, respectively, of which the net carrying value was $0.5 million and $0.9 million, respectively, and is included as 'Notes payable' in the accompanying condensed consolidated balance sheets.

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As of September 30, 2017 and December 31, 2016, the Company’s outstanding debt is summarized as follows (in thousands):
 
 
September 30, 2017
 
December 31, 2016
Promissory note to USAC
 
$

 
$
120

FCC civil penalty
 
500

 
1,000

Total notes payable, gross
 
500

 
1,120

Less: discount
 
(18
)
 
(79
)
Total notes payable, net carrying value
 
482

 
1,041

Revolving line of credit
 
32,594

 
32,594

Interest accretion under 2016 line of credit
 
4

 
19

Total debt, net carrying value
 
$
33,080

 
$
33,654

Less: current portion of debt *
 
$
(486
)
 
$
(742
)
Total debt, less current portion **
 
$
32,594

 
$
32,912

 
 
 
 
 
 
 
 
 
 
* Included in ‘Notes payable’ in the condensed consolidated balance sheets.
** Included in ‘Notes payable - less current portion’ and 'Revolving line of credit — less current portion' in the condensed consolidated balance sheets.
Maturities of the Company’s outstanding debt as of September 30, 2017 are as follows (in thousands):
Period
 
Amount to Mature
2017
 
$
167

2018
 
333

2019
 
32,594

Total
 
$
33,094

6. Stockholders’ Equity
Capital Structure
The Company is authorized to issue 450,000,000 shares of common stock with a par value of $0.001 per share. As of September 30, 2017 and December 31, 2016, the Company had 55,631,423 and 53,363,013 shares of common stock issued and outstanding, respectively.
The Company is also authorized to designate and issue up to 5,000,000 shares of preferred stock with a par value of $0.001 per share in one or more series without stockholder approval and to fix the rights, preferences, privileges and restrictions thereof. As of September 30, 2017 and December 31, 2016, the Company had no shares of preferred stock issued and outstanding.
Warrants
As of September 30, 2017 and December 31, 2016, the Company had outstanding warrants to purchase 13,013 and 131,597 shares of common stock, respectively, with a weighted-average exercise price of $5.76 per share and $9.80 per share, respectively. The warrants outstanding as of September 30, 2017 will expire on October 18, 2023.

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Common Stock Reserved for Future Issuance
Shares of common stock reserved for future issuance related to outstanding equity awards, common stock warrants, and employee equity incentive plans were as follows (in thousands):
 
 
September 30, 2017
Stock options outstanding
 
4,597

Restricted stock units outstanding
 
2,133

Shares available for future grant under 2014 Plan
 
7,526

Shares available for future issuance under ESPP
 
1,495

Common stock warrants outstanding
 
13

Total shares of common stock reserved
 
15,764

Equity Incentive Plans 
Prior to its initial public offering (“IPO”), the Company granted stock options under its Amended and Restated 2004 Equity Incentive Plan, as amended (the “2004 Plan”).
In March 2014, the Company’s board of directors and stockholders approved the 2014 Equity Incentive Plan (“2014 Plan”) and 5,300,000 shares of common stock were reserved for issuance under the 2014 Plan. In addition, on the first day of each year beginning in 2015 and ending in 2024, the 2014 Plan provides for an annual automatic increase to the shares reserved for issuance in an amount equal to 5% of the total number of shares outstanding on December 31st of the preceding calendar year or a lesser number as determined by the Company’s board of directors. Pursuant to the automatic annual increase, 2,668,150 and 2,558,231 additional shares were reserved under the 2014 Plan on January 1, 2017 and 2016, respectively.
No further grants were made under the 2004 Plan once the 2014 Plan became effective on April 3, 2014. Upon the effectiveness of the 2014 Plan, all shares reserved for future issuance under the 2004 Plan became available for issuance under the 2014 Plan. After the IPO, any forfeited or expired shares that would have otherwise returned to the 2004 Plan instead return to the 2014 Plan.
The 2004 Plan and the 2014 Plan are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
Stock Options
A summary of the Company’s stock option activity during the nine months ended September 30, 2017 is as follows (in thousands, except years and per share data):
 
 
Number of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Life
(Years)
 
Aggregate
Intrinsic
Value
Outstanding as of December 31, 2016
 
5,556

 
$
5.23

 
 
 
 
Options granted (weighted average grant date fair value of $8.20 per share)
 
511

 
16.83

 
 
 
 
Options exercised
 
(1,336
)
 
2.46

 
 
 
 
Options forfeited or expired
 
(134
)
 
12.64

 
 
 
 
Outstanding as of September 30, 2017
 
4,597

 
$
7.10

 
6.3
 
$
77,235

The Company has computed the aggregate intrinsic value amounts disclosed in the above table based on the difference between the exercise price of the options and the closing market price of the Company’s common stock of $23.90 per share as of September 30, 2017 for all in-the-money options outstanding.

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Restricted Stock Units
A summary of the Company's restricted stock unit ("RSU") activity during the nine months ended September 30, 2017 is as follows (in thousands, except per share data):     
 
 
Number of Shares
 
Weighted Average Grant Date Fair Value Per Share
Outstanding as of December 31, 2016
 
2,019

 
$
7.65

RSUs granted
 
1,022

 
17.31

RSUs vested and released
 
(745
)
 
8.68

RSUs forfeited
 
(163
)
 
10.92

Outstanding as of September 30, 2017
 
2,133

 
$
11.62

Employee Stock Purchase Plan
The Company's 2014 Employee Stock Purchase Plan ("ESPP") became effective on April 3, 2014 and is described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016. The number of shares of common stock originally reserved for issuance under the ESPP was 880,000 shares, which will increase automatically each year, beginning on January 1, 2015 and continuing through January 1, 2024, by the lesser of (i) 1% of the total number of shares of the Company’s common stock outstanding on December 31 of the preceding calendar year; (ii) 1,000,000 shares of common stock (subject to adjustment to reflect any split or combination of the Company’s common stock); or (iii) such lesser number as determined by the Company’s board of directors. Pursuant to the automatic annual increase, 533,630 and 511,646 additional shares were reserved under the ESPP on January 1, 2017 and 2016, respectively.
One purchase event occurred during the nine months ended September 30, 2017 as follows: 141,222 shares were purchased on May 15, 2017 at a price of $12.75 per share under the ESPP.
Stock-Based Compensation
Stock-based compensation expenses for the three and nine months ended September 30, 2017 and 2016 were as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Cost of revenue
 
$
599

 
$
357

 
$
1,608

 
$
951

Research and development
 
797

 
547

 
2,235

 
1,510

Sales and marketing
 
1,084

 
626

 
3,236

 
1,604

General and administrative
 
1,240

 
989

 
3,624

 
2,862

Total stock-based compensation
 
$
3,720

 
$
2,519

 
$
10,703

 
$
6,927

As of September 30, 2017, unrecognized stock-based compensation expenses by award type and their expected weighted-average recognition periods are summarized in the following table (in thousands, except years).
 
 
Stock Option
 
RSU
 
ESPP
Unrecognized stock-based compensation expense
 
$
6,461

 
$
23,056

 
$
181

Weighted-average amortization period
 
2.8 years

 
2.9 years

 
0.1 years

The Company recognizes stock-based compensation expense that is calculated based upon awards that have vested, reduced for actual forfeitures. All stock-based compensation for equity awards granted to employees and non-employee directors is measured based on the grant date fair value of the award.

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The Company values RSUs at the closing market price of its common stock on the date of grant. The Company estimates the fair value of each stock option and purchase right under the ESPP granted to employees on the date of grant using the Black-Scholes option-pricing model and using the assumptions noted in the below table. The weighted-average assumptions used to value stock options granted during the three and nine months ended September 30, 2017 and 2016 were as follows:
Stock Options
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Expected term (years)
 
6.1
 
6.1
 
6.2
 
6.0
Volatility
 
53%
 
48%
 
49%
 
48%
Risk-free interest rate
 
2.0%
 
1.2%
 
2.0%
 
1.5%
Dividend yield
 
 
 
 
7. Net Income (Loss) Per Share
Basic net income (loss) per share is calculated by dividing net income (loss) by the weighted average number of common shares outstanding during the period, and excludes any dilutive effects of employee stock-based awards and warrants. Diluted net income (loss) per share is computed giving effect to all potentially dilutive common shares, including common stock issuable upon exercise of stock options and warrants and vesting of restricted stock units.
The following table presents the calculation of basic and diluted net income (loss) per share (in thousands, except per share data).
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Net income (loss)
 
$
924

 
$
(3,890
)
 
$
(8,338
)
 
$
(12,269
)
Weighted-average shares of common stock outstanding
 
55,310

 
52,708

 
54,579

 
52,078

Basic net income (loss) per share
 
$
0.02

 
$
(0.07
)
 
$
(0.15
)
 
$
(0.24
)
 
 
 
 
 
 
 
 
 
Net income (loss)
 
$
924

 
$
(3,890
)
 
$
(8,338
)
 
$
(12,269
)
Weighted-average shares of common stock outstanding
 
55,310

 
52,708

 
54,579

 
52,078

Effect of dilutive shares
 
4,131

 

 

 

Weighted average shares of common stock outstanding
 
59,441

 
52,708

 
54,579

 
52,078

Diluted net income (loss) per share
 
$
0.02

 
$
(0.07
)
 
$
(0.15
)
 
$
(0.24
)
The following securities were excluded from the calculation of diluted net income (loss) per share because their effect would have been anti-dilutive (in thousands).
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Stock options
 
471

 
5,626

 
4,597

 
5,626

Restricted stock units
 
29

 
2,096

 
2,133

 
2,096

Common stock warrants
 

 
132

 
13

 
132

Total
 
500

 
7,854

 
6,743

 
7,854

8. Income Taxes
The provision for income taxes for the three and nine months ended September 30, 2017 was approximately $43 thousand and $142 thousand, respectively. The provision for/(benefit from) income taxes for the three and nine months ended September 30, 2016 was approximately $(2) thousand and $68 thousand, respectively. The provision for income taxes consisted primarily of foreign income taxes.

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For the three and nine months ended September 30, 2017 and 2016, the provision for income taxes differed from the statutory amount primarily due to the Company realizing no benefit for current year losses due to maintaining a full valuation allowance against its domestic net deferred tax assets.
The realization of tax benefits of deferred tax assets is dependent upon future levels of taxable income, of an appropriate character, in the periods the items are expected to be deductible or taxable. Based on the available objective evidence, the Company does not believe it is more likely than not that the net deferred tax assets will be realizable. Accordingly, the Company has provided a full valuation allowance against the domestic net deferred tax assets as of September 30, 2017 and December 31, 2016. The Company intends to maintain the remaining valuation allowance until sufficient positive evidence exists to support a reversal of, or decrease in, the valuation allowance. During the three and nine months ended September 30, 2017, there were no material changes to the total amount of unrecognized tax benefits. 
9. Commitments and Contingencies
Commitments
The Company’s principal commitments consist of future payment obligations under capital leases to finance data centers and other computer and networking equipment purchases, debt agreements (see Note 5), operating lease agreements for office space, research and development, and sales and marketing facilities, and agreements with third parties to provide co-location hosting, telecommunication usage and equipment maintenance services. These commitments as of December 31, 2016 are disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2016, and did not change materially during the nine months ended September 30, 2017 except for the acquisition of certain additional data center and network equipment and software under multiple capital leases, and certain hosting and telecommunications agreements. As of September 30, 2017, the total minimum future payment commitments under these capital leases added during the nine months ended September 30, 2017 were approximately $7.5 million, of which $0.7 million is due during the remainder of 2017, with the remainder of $6.8 million due over approximately 35 months. The Company entered into various hosting and telecommunications agreements for terms of 11 to 36 months commencing on various dates in the first three quarters of 2017. These agreements require the Company to make monthly payments over the service term in exchange for certain network services. The Company's total minimum future payment commitments under these agreements are $4.3 million.
Universal Services Fund Liability
During the third quarter of 2012, the Company determined that based on its business activities, it is classified as a telecommunications service provider for regulatory purposes and it should make direct contributions to the federal USF and related funds based on revenues it receives from the resale of interstate and international telecommunications services. In order to comply with the obligation to make direct contributions, the Company made a voluntary self-disclosure to the FCC Enforcement Bureau and registered with the USAC, which is charged by the FCC with administering the USF. The Company filed exemption certificates with its wholesale telecommunications service providers in order to eliminate its obligation to reimburse such wholesale telecommunications service providers for their USF contributions calculated on services sold to the Company. In April 2013, the Company began remitting required contributions on a prospective basis directly to USAC.
The Company’s registration with USAC subjects it to assessments for unpaid USF contributions, as well as interest thereon and civil penalties, due to its late registration and past failure to recognize its obligation as a USF contributor and as an international carrier. The Company is required to pay assessments for periods prior to the Company’s registration. As of December 31, 2012, the total past due USF contribution being imposed by USAC and accrued by the Company for the period from 2003 through 2012 was $8.1 million, of which $4.7 million was undisputed and $3.4 million was disputed. The Company subsequently updated its filings and increased the liability related to 2008 through 2012 by $0.5 million, arriving at a new total of $3.9 million in disputed liability. In July 2013, the Company and USAC agreed to a financing arrangement for $4.1 million of the undisputed $4.7 million of the unpaid USF contributions whereby the Company issued to USAC a promissory note payable in the principal amount of the $4.1 million and paid off the remaining undisputed $0.6 million. The Company had fully paid the promissory note as of January 2017.
In January 2017, the FCC’s Wireline Competition Bureau ruled in the Company's favor with respect to most of the disputed amount. In September 2017, USAC issued a credit to the Company reflecting the FCC's ruling for the $3.1 million of the $3.9 million in disputed liability. In addition, USAC reversed the interest and penalties related to the disputed liability of $3.1 million. The remaining $0.8 million in dispute involves USAC’s assessment

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of liability for the period of 2003 through 2007, which was prior to the five year window during which the Company was required to maintain financial records for USF contribution purposes. The Company filed a Request for Review (a form of appeal) of this disputed amount with the FCC's Wireline Competition Bureau in 2013, which remains pending. If the Request for Review is not resolved in the Company’s favor, it is possible that the Company will be held to the back assessments of $0.8 million, which includes interest and penalties on that amount.
As of September 30, 2017, the accrued liability on the remaining disputed assessments, including interest and penalties for the period of 2003 through 2007, was $0.8 million offset by $0.7 million in other USF credits.
State and Local Taxes and Surcharges
In April 2012, the Company commenced collecting and remitting sales taxes on sales of subscription services in all the U.S. states in which it determined it was obligated to do so. During the first quarter of 2015, the Company conducted an updated sales tax review of the taxability of sales of its subscription services. As a result, the Company determined that it may be obligated to collect and remit sales taxes on such sales in four additional states. Based on its best estimate of the probable sales tax liability in those four states relating to its sales of subscription services during the period 2011 through 2014, during the three months ended March 31, 2015, the Company recorded a general and administrative expense of $0.6 million to accrue for such taxes.
During 2013, the Company analyzed its activities and determined it may be obligated to collect and remit various state and local taxes and surcharges on its usage-based fees. The Company had not remitted state and local taxes on usage-based fees in any of the periods prior to 2014 and therefore accrued a sales tax liability for this contingency. In January 2014, the Company commenced paying such taxes and surcharges to certain state authorities. In June 2014, the Company commenced collecting state and local taxes or surcharges on usage-based fees from its clients on a current basis and remitting such taxes to the applicable U.S. state taxing authorities.
During the three and nine months ended September 30, 2017, the Company made no payments for its contingent sales taxes on either usage-based fees or sales of subscription services. During the three and nine months ended September 30, 2016, the Company remitted $0.5 thousand and $0.1 million, respectively, for its contingent sales taxes on both usage-based fees and sales of subscription services. For the three and nine months ended September 30, 2017, the Company recognized a gain of $0.2 million and $0.5 million, respectively, as an offset to general and administrative expense related to its estimated sales tax liability on both usage-based fees and sales of subscription services in the U.S. and Canada. For the three and nine months ended September 30, 2016, the Company recognized a gain of $0.1 million and $0.3 million, respectively, as an offset to general and administrative expense related to its estimated sales tax liability on both usage-based fees and sales of subscription services in the U.S. and Canada, which was not being collected from its clients.
As of September 30, 2017 and December 31, 2016, the Company had total accrued liabilities of $1.6 million and $2.1 million, respectively, for such contingent sales taxes and surcharges that were not being collected from its clients but may be imposed by various taxing authorities, of which $0.5 million and $0.6 million, respectively, were included in current “Sales tax liability” on the condensed consolidated balance sheets, and the remaining were included in non-current “Sales tax liability” on the condensed consolidated balance sheets. The Company’s estimate of the probable loss incurred under this contingency is based on its analysis of the source location of its usage-based fees and the regulations and rules in each tax jurisdiction.
Legal Matters
The Company is involved in various legal and regulatory matters arising in the normal course of business. In management’s opinion, resolution of these matters is not expected to have a material impact on the Company’s consolidated results of operations, cash flows, or its financial position. However, due to the uncertain nature of legal matters, an unfavorable resolution of a matter could materially affect the Company’s future consolidated results of operations, cash flows or financial position in a particular period. The Company expenses legal fees as incurred.
The Company is currently involved in the following lawsuits as a defendant.

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Melcher Litigation
On September 28, 2016, a complaint was filed in the United States District Court for the Southern District of California against Five9, Inc., or Five9, as the successor in interest to Face It, Corp., or Face It, and Lance Fried, a former Five9 employee who was the former Chief Executive Officer of Face It. The action, captioned Melcher, et al. v. Five9, Inc., et al., No. 16-cv-02440, or the Melcher Litigation, was filed as a direct action by Carl Melcher, or Melcher, a purported former stockholder of Face It, and his related investment entity Melcher Family Limited Partnership, or MFLP.
In the complaint, the plaintiffs alleged that Face It repurchased the plaintiffs’ stock in September 2013 before Five9 acquired Face It, and that in connection with the repurchase, Fried made material misstatements or omissions to Melcher, by failing to disclose that Face It allegedly was in concurrent discussions about a potential sale of the company to Five9. The complaint alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, as well as various claims under state law and common law. The complaint sought to set aside Face It’s September 2013 stock repurchase from the plaintiffs, as well as an unspecified amount of damages and an award of attorney’s fees and costs, in addition to other relief.
On November 8, 2016, the court entered an order staying the lawsuit and ordered the parties to proceed to arbitration of the dispute before the American Arbitration Association, or AAA. On November 16, 2016, Melcher and MFLP submitted a Demand for Arbitration to AAA against Five9, asserting claims identical to those alleged in the lawsuit.
On March 31, 2017, Five9 reached a settlement with the plaintiffs that fully resolved the plaintiffs’ claims against Five9 and provided for mutual releases between the plaintiffs and Five9 in exchange for a one-time payment by Five9 to the plaintiffs of $1.7 million. As a result of the settlement, the AAA arbitration was concluded, and on July 10, 2017 the plaintiffs filed an amended complaint in the Melcher Litigation solely against Fried, removing Five9 as a defendant.
NobelBiz Litigation
On August 5, 2011, NobelBiz sent a letter to the Company asserting infringement of a patent related to virtual call centers. On April 3, 2012, NobelBiz filed a patent infringement lawsuit against the Company in the United States District Court for the Eastern District of Texas. The patent asserted in the complaint is different, but related, to the patent asserted in the original letter. The lawsuit, NobelBiz Inc. v. Five9, Inc., Case No. 6:12-cv-00243-LED, alleges that the Company’s local caller ID management service infringes United States Patent No. 8135122, or the ‘122 patent. The ‘122 patent, titled “System and Method for Modifying Communication Information (MCI),” issued on March 13, 2012, and according to the complaint is alleged to relate to “a system for processing a telephone call from a call originator (also referred to as a calling party) to a call target (also referred to as a receiving party), where the system accesses a database storing outgoing telephone numbers, selects a replacement telephone number from the outgoing telephone numbers based on the telephone number of the call target, and originates an outbound call to the call target with a modified outgoing caller identification (‘caller ID’).” NobelBiz seeks damages in the form of lost profits as well as injunctive relief. The lawsuit is one of several lawsuits filed by NobelBiz against various companies including TCN Inc., LiveVox, Inc. and Global Connect LLC. On March 28, 2013, the court granted the Company’s motion to transfer the case to the United States District Court for the Northern District of California. Subsequently, NobelBiz amended its complaint to add claims related to U.S. Patent No. 8565399, or the ‘399 patent, which is a continuation in the same family as the ‘122 patent and addresses the same technology. The Company responded to the complaint and amended complaint by asserting noninfringement and invalidity of the ‘122 and ‘399 patents. On January 16, 2015, the court issued an order regarding claim construction of the two patents-in-suit. On March 7, 2016, the court stayed the case pending an appeal in lawsuits involving NobelBiz, Global Connect and TCN that also involve the ‘122 and ‘399 patents. On July 19, 2017, the Federal Circuit Court of Appeal issued a ruling confirming the claim construction in Five9’s lawsuit and resolving the appeal in favor of Global Connect and TCN and against NobelBiz. Subsequently, the district court set a new schedule for the litigation in light of this ruling with motions for summary judgment set to occur in 2018.
The Company has investigated the claims alleged in the complaint and believes that it has good defenses to the claims. While the Company does not believe that it is probable that a loss has been incurred, the ultimate resolution of the matter could potentially result in a loss. Management’s best estimate of the low end of the range of the potential loss is zero. At this time, it is not possible to reasonably estimate the high end of the range of the potential loss, which could be material to the Company’s results of operations. Accordingly, the Company has not accrued a loss related to this matter.

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Indemnification Agreements
In the ordinary course of business, the Company enters into agreements of varying scope and terms pursuant to which it agrees to indemnify clients, vendors, lessors, business partners and other parties with respect to certain matters, including, but not limited to, losses arising out of breach of such agreements, services to be provided by the Company or from intellectual property infringement claims made by third parties. In addition, the Company has entered into indemnification agreements with directors and certain officers and employees that will require it, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors, officers or employees. Other than as described below, no demands have been made upon the Company to provide indemnification under such agreements and there are no claims that it is aware of that could have a material effect on the consolidated balance sheet, consolidated statement of operations and comprehensive loss, or consolidated statements of cash flows. On October 27, 2016, the Company received notice from Lance Fried, a former officer and director of Face It, of his claim for indemnification by the Company (as successor in interest to Face It), and for advancement of all legal fees and expenses he incurs in connection with the defense of the Melcher Litigation. See "Legal Matters" above. As of May 31, 2017, the Company had advanced Mr. Fried $62 thousand in connection with this claim; however, the Company disputes that Mr. Fried is entitled to advancement in connection with the Melcher Litigation. On July 31, 2017, Mr. Fried filed a complaint against the Company in the Court of Chancery for the State of Delaware, in which he alleges that the Company breached advancement obligations to him. In the lawsuit, Mr. Fried seeks advancement of his legal fees and expenses in connection with the defense of the Melcher Litigation, payment of his legal fees and expenses incurred in connection with his advancement action, and interest. The Company believes the action is without merit and is defending it vigorously. Regardless of the outcome of Mr. Fried’s advancement lawsuit against the Company, Mr. Fried is required to reimburse the Company for any amounts advanced to him if it is ultimately determined that Mr. Fried is not entitled to indemnification in connection with the Melcher Litigation. In addition, the Company believes that it has indemnification rights against the former stockholders of Face It (including Mr. Fried) for all losses that are incurred by the Company in connection with the Melcher Litigation, including without limitation, amounts incurred to indemnify or advance the legal fees and expenses of Mr. Fried pursuant to his indemnification claim against the Company.
10. Geographical Information
The following table is a summary of revenues by geographic region based on client billing address and has been estimated based on the amounts billed to clients during the periods presented (in thousands).
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
United States
 
$
46,897

 
$
38,251

 
$
136,085

 
$
109,948

International
 
3,184

 
2,731

 
8,737

 
7,935

Total revenue
 
$
50,081

 
$
40,982

 
$
144,822

 
$
117,883

The following table summarizes total property and equipment, net in the respective locations (in thousands).
 
 
September 30, 2017
 
December 31,
2016
United States
 
$
16,585

 
$
13,025

International
 
1,373

 
1,663

Property and equipment, net
 
$
17,958

 
$
14,688

    

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2016.
Overview
We are a pioneer and leading provider of cloud software for contact centers, facilitating more than three billion interactions between our more than 2,000 clients and their customers per year. We believe we achieved this leadership position through our expertise and technology, which has empowered us to help organizations of all sizes transition from legacy on-premise contact center systems to our cloud solution. Our solution, which is comprised of our Virtual Contact Center, or VCC, cloud platform and applications, allows simultaneous management and optimization of customer interactions across voice, chat, email, web, social media and mobile channels, either directly or through our application programming interfaces, or APIs. Our VCC cloud platform routes each customer interaction to an appropriate agent resource, and delivers relevant customer data to the agent in real-time to optimize the customer experience. Unlike legacy on-premise contact center systems, our solution requires minimal up-front investment and can be rapidly deployed and adjusted depending on our client’s requirements.
Since founding our business in 2001, we have focused exclusively on delivering cloud contact center software. We initially targeted smaller contact center opportunities with our telesales team and, over time, invested in expanding the breadth and depth of the functionality of our cloud platform to meet the evolving requirements of our clients. In 2009, we made a strategic decision to expand our market opportunity to include larger contact centers. This decision drove further investments in research and development and the establishment of our field sales team to meet the requirements of these larger contact centers. We believe this shift has helped us diversify our client base while significantly enhancing our opportunity for future revenue growth. To complement these efforts, we have also focused on building client awareness and driving adoption of our solution through marketing activities, which include internet advertising, digital marketing campaigns, social marketing, trade shows, industry events and telemarketing.
We provide our solution through a SaaS business model with recurring subscriptions. We offer a comprehensive suite of applications delivered on our VCC cloud platform that are designed to enable our clients to manage and optimize both inbound and outbound interactions. We primarily generate revenue by selling subscriptions and related usage of our VCC cloud platform. We charge our clients monthly subscription fees for access to our solution, primarily based on the number of agent seats, as well as the specific functionalities and applications our clients deploy. We define agent seats as the maximum number of named agents allowed to concurrently access our solution. Our clients typically have more named agents than agent seats, and multiple named agents may use an agent seat, though not simultaneously. Substantially all of our clients purchase both subscriptions and related telephony usage from us. A small percentage of our clients subscribe to our platform but purchase telephony usage directly from wholesale telecommunications service providers. We do not sell telephony usage on a stand-alone basis to any client. The related usage fees are based on the volume of minutes for inbound and outbound interactions. We also offer bundled plans, generally for smaller deployments, where the client is charged a single monthly fixed fee per agent seat that includes both subscription and unlimited usage in the contiguous 48 states and, in some cases, Canada. We offer monthly, annual and multiple-year contracts to our clients, generally with 30 days’ notice required for changes in the number of agent seats. Our clients can use this notice period to rapidly adjust the number of agent seats used to meet their changing contact center volume needs, including to reduce the number of agent seats to zero. As a general matter, this means that a client can effectively terminate its agreement with us upon 30 days’ notice. Our larger clients typically choose annual contracts, which generally include an implementation and ramp period of several months. Fixed subscription fees, including bundled plans, are generally billed monthly in advance, while related usage fees are billed in arrears. For the three and nine months ended September 30, 2017, subscription and related usage fees accounted for 93% and 94% of our revenue. For the three and nine months ended September 30, 2016, subscription and related usage fees accounted for 96% and 95% of our revenue, respectively. The remainder was comprised of professional services revenue from the implementation and optimization of our solution.
Our revenue increased to $50.1 million and $144.8 million for the three and nine months ended September 30, 2017 from $41.0 million and $117.9 million for the three and nine months ended September 30, 2016. Revenue growth has primarily been driven by our larger clients. For each of the three and nine months ended September 30, 2017 and 2016, no single client accounted for more than 10% of our total revenue. As of September 30, 2017, we had over 2,000 clients across multiple industries. Our clients' subscriptions generally range in size from fewer than

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10 agent seats to approximately 1,000 agent seats. We had net income of $0.9 million and net loss of $8.3 million in the three and nine months ended September 30, 2017, compared to net loss of $3.9 million and $12.3 million for each of the three and nine months ended September 30, 2016.
We have continued to make significant expenditures and investments, including in sales and marketing, research and development and infrastructure. We primarily evaluate the success of our business based on revenue growth, adjusted EBITDA and the efficiency and effectiveness of our investments. The growth of our business and our future success depend on many factors, including our ability to continue to expand our client base, particularly in larger opportunities, grow revenue from our existing client base, develop innovative products and features, and expand internationally. While these areas represent significant opportunities for us, they also pose risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results. In order to pursue these opportunities, we anticipate that we will continue to expand our operations and headcount in the near term.
Due to our continuing investments to grow our business, increase our sales and marketing efforts, pursue new opportunities, enhance our solution and build our technology, we expect our cost of revenue and operating expenses to increase in absolute dollars in future periods. However, we expect these expenses to decrease as a percentage of revenue as we grow our revenue and gain economies of scale by increasing our client base without direct incremental development costs and by utilizing more of the capacity of our data centers.
Key Operating and Financial Performance Metrics
In addition to measures of financial performance presented in our condensed consolidated financial statements, we monitor the key metrics set forth below to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies.
Annual Dollar-Based Retention Rate
We believe that our Annual Dollar-Based Retention Rate provides insight into our ability to retain and grow revenue from our clients, and is a measure of the long-term value of our client relationships. Our Annual Dollar-Based Retention Rate is calculated by dividing our Retained Net Invoicing by our Retention Base Net Invoicing on a monthly basis, which we then average using the rates for the trailing twelve months for the period being presented. We define Retention Base Net Invoicing as recurring net invoicing from all clients in the comparable prior year period, and we define Retained Net Invoicing as recurring net invoicing from that same group of clients in the current period. We define recurring net invoicing as subscription and related usage revenue excluding the impact of service credits, reserves and deferrals. Historically, the difference between recurring net invoicing and our subscription and related usage revenue has been within 10%.
The following table shows our Annual Dollar-Based Retention Rate for the periods presented:
 
 
Twelve Months Ended
 
 
September 30, 2017
 
September 30, 2016
Annual Dollar-Based Retention Rate
 
98%
 
100%
Our Dollar-Based Retention Rate declined year over year primarily due to the prior year period benefits from the ramp of one of our largest customers.
Adjusted EBITDA
We monitor adjusted EBITDA, a non-GAAP financial measure, to analyze our financial results and believe that it is useful to investors, as a supplement to U.S. GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance. We believe that adjusted EBITDA helps illustrate underlying trends in our business that could otherwise be masked by the effect of the income or expenses that we exclude from adjusted EBITDA. Furthermore, we use this measure to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that adjusted EBITDA provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry.
Adjusted EBITDA should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP and our calculation of adjusted EBITDA may differ from that of other companies in our industry. We compensate for the inherent limitations associated with using adjusted EBITDA

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through disclosure of these limitations, presentation of our financial statements in accordance with U.S. GAAP and reconciliation of adjusted EBITDA to the most directly comparable U.S. GAAP measure, net income (loss). We calculate adjusted EBITDA as net income (loss) before (1) depreciation and amortization, (2) stock-based compensation, (3) interest income, expense and other, (4) provision for income taxes, and (5) other unusual items that do not directly affect what we consider to be our core operating performance.
The following table shows a reconciliation from net income (loss) to Adjusted EBITDA for the periods presented (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Net income (loss)
 
$
924

 
$
(3,890
)
 
$
(8,338
)
 
$
(12,269
)
Non-GAAP adjustments:
 
 
 
 
 
 
 
 
Depreciation and amortization (1)
 
1,881

 
2,140

 
6,246

 
6,302

Stock-based compensation (2)
 
3,720

 
2,519

 
10,703

 
6,927

Extinguishment of debt
 

 
1,026

 

 
1,026

Interest expense
 
865

 
961

 
2,635

 
3,357

Interest income and other
 
(118
)
 
(12
)
 
(326
)
 
66

Legal settlement (3)
 

 

 
1,700

 

Legal and indemnification fees related to settlement (3)
 

 

 
135

 

Reversal of interest and penalties on accrued federal fees (4)
 
(2,133
)
 

 
(2,133
)
 

Provision for (benefit from) income taxes
 
43

 
(2
)
 
142

 
68

Adjusted EBITDA
 
$
5,182

 
$
2,742

 
$
10,764

 
$
5,477

 
 
 
 
 
 
 
 
 
(1) Depreciation and amortization expenses included in our results of operations are as follows (in thousands):
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Cost of revenue
 
$
1,397

 
$
1,668

 
$
4,689

 
$
4,964

Research and development
 
182

 
204

 
625

 
513

Sales and marketing
 
30

 
56

 
90

 
163

General and administrative
 
272

 
212

 
842

 
662

Total depreciation and amortization
 
$
1,881

 
$
2,140

 
$
6,246

 
$
6,302

(2) See Note 6 of the notes to condensed consolidated financial statements for stock-based compensation expense included in our results of operations for the periods presented.
(3) Represents settlement amount, legal and indemnification fees related to the settlement of the Melcher litigation. See Note 9 of the notes to condensed consolidated financial statements.
(4)
Represents the reversal of accrued interest and penalties related to the Universal Services Fund ("USF") liability following a favorable ruling from the FCC's Wireline Competition Bureau. See Note 9 of the notes to condensed consolidated financial statements for additional information.
Key Components of Our Results of Operations
Revenue
Our revenue consists of subscription and related usage as well as professional services. We consider our subscription and related usage to be recurring revenue. This recurring revenue includes fixed subscription fees for the delivery and support of our VCC cloud platform, as well as related usage fees. The related usage fees are based on the volume of minutes for inbound and outbound client interactions. We also offer bundled plans, generally for smaller deployments, where the client is charged a single monthly fixed fee per agent seat that includes both

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subscription and unlimited usage in the contiguous 48 states and, in some cases, Canada. We offer monthly, annual and multiple-year contracts for our clients, generally with 30 days’ notice required for changes in the number of agent seats. Our clients can use this notice period to rapidly adjust the number of agent seats used to meet their changing contact center volume needs, including to reduce the number of agent seats to zero. As a general matter, this means that a client can effectively terminate its agreement with us upon 30 days’ notice.
Fixed subscription fees, including plans with bundled usage, are generally billed monthly in advance, while variable usage fees are billed in arrears. Fixed subscription fees are recognized on a straight-line basis over the applicable term, predominantly the monthly contractual billing period. Support activities include technical assistance for our solution and upgrades and enhancements on a when and if available basis, which are not billed separately. Variable subscription related usage fees for non-bundled plans are billed in arrears based on client-specific per minute rate plans and are recognized as actual usage occurs. We generally require advance deposits from clients based on estimated usage. All fees, except usage deposits, are non-refundable.
In addition, we generate professional services revenue from assisting clients in implementing our solution and optimizing use. These services include application configuration, system integration and education and training services. Professional services are primarily billed on a fixed-fee basis and are typically performed by us directly. In limited cases, our clients choose to perform these services themselves or engage their own third-party service providers to perform such services. Professional services are recognized as the services are performed using the proportional performance method, with performance measured based on labor hours, provided all other criteria for revenue recognition are met.
Cost of Revenue
Our cost of revenue consists primarily of personnel costs (including stock-based compensation), fees that we pay to telecommunications providers for usage, USF contributions and other regulatory costs, depreciation and related expenses of the servers and equipment, costs to build out and maintain co-location data centers, and allocated office and facility costs and amortization of acquired technology. Cost of revenue can fluctuate based on a number of factors, including the fees we pay to telecommunications providers, which vary depending on our clients’ usage of our VCC cloud platform, the timing of capital expenditures and related depreciation charges and changes in headcount. We expect to continue investing in our network infrastructure and operations and client support function to maintain high quality and availability of service, resulting in absolute dollar increases in Cost of Revenue. As our business grows, we expect to realize economies of scale in network infrastructure, personnel and client support.
Operating Expenses
We classify our operating expenses as research and development, sales and marketing, and general and administrative expenses.
Research and Development.    Our research and development expenses consist primarily of salary and related expenses (including stock-based compensation) for personnel related to the development of improvements and expanded features for our services, as well as quality assurance, testing, product management and allocated overhead. We expense research and development expenses as they are incurred except for internal-use software development costs that qualify for capitalization. We believe that continued investment in our solution is important for our future growth, and we expect research and development expenses to increase in absolute dollars in the foreseeable future, although these expenses as a percentage of our revenue are expected to decrease over time.
Sales and Marketing.    Sales and marketing expenses consist primarily of salaries and related expenses (including stock-based compensation) for personnel in sales and marketing, sales commissions, as well as advertising, marketing, corporate communications, travel costs and allocated overhead. We expense sales commissions associated with the acquisition of client contracts as incurred in the period the contract is acquired. We believe it is important to continue investing in sales and marketing to continue to generate revenue growth. Accordingly, we expect sales and marketing expenses to increase in absolute dollars as we continue to support our growth initiatives.
General and Administrative.    General and administrative expenses consist primarily of salary and related expenses (including stock-based compensation) for management, finance and accounting, legal, information systems and human resources personnel, professional fees, compliance costs, other corporate expenses and allocated overhead. We expect that general and administrative expenses will fluctuate in absolute dollars from period to period, but decline as a percentage of revenue over time.

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Other Income (Expense), Net
Other income (expense), net consists primarily of interest expense associated with our debt and capital leases. We expect interest expense for our outstanding debt to decrease due to a lower interest rate for our New Revolving Credit Facility compared to the 2014 Loan and Security Agreement and the 2013 Loan and Security Agreement (see Note 5 of the notes to condensed consolidated financial statements). We expect interest expense for our capital leases to increase as a result of our continued capital spending funded by capital leases.
Provision for Income Taxes
Our provision for income taxes consists primarily of corporate income taxes resulting from profits generated in foreign jurisdictions by our wholly-owned subsidiaries, along with state income taxes payable in the United States.
Results of Operations for the Three and Nine Months Ended September 30, 2017 and 2016
Based on the condensed consolidated statements of operations and comprehensive loss set forth in this Quarterly Report on Form 10-Q, the following table sets forth our operating results as a percentage of revenue for the periods indicated:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Revenue
 
100
 %
 
100
 %
 
100
 %
 
100
 %
Cost of revenue
 
41
 %
 
43
 %
 
42
 %
 
43
 %
Gross profit
 
59
 %
 
57
 %
 
58
 %
 
57
 %
Operating expenses:
 
 
 
 
 
 
 
 
Research and development
 
13
 %
 
15
 %
 
14
 %
 
15
 %
Sales and marketing
 
33
 %
 
32
 %
 
34
 %
 
32
 %
General and administrative
 
10
 %
 
15
 %
 
14
 %
 
17
 %
Total operating expenses
 
56
 %
 
62
 %
 
62
 %
 
64
 %
Income (loss) from operations
 
3
 %
 
(5
)%
 
(4
)%
 
(7
)%
Other income (expense), net:
 
 
 
 
 
 
 
 
Extinguishment of debt
 
 %
 
(3
)%
 
 %
 
(1
)%
Interest expense
 
(2
)%
 
(2
)%
 
(2
)%
 
(3
)%
Interest income and other
 
1
 %
 
1
 %
 
 %
 
1
 %
Total other income (expense), net
 
(1
)%
 
(4
)%
 
(2
)%
 
(3
)%
Income (loss) before income taxes
 
2
 %
 
(9
)%
 
(6
)%
 
(10
)%
Provision for (benefit from) income taxes
 
 %
 
 %
 
 %
 
 %
Net income (loss)
 
2
 %
 
(9
)%
 
(6
)%
 
(10
)%
Revenue
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Revenue
 
$50,081
 
$40,982
 
$9,099
 
22%
 
$144,822
 
$117,883
 
$26,939
 
23%
The increase in revenue for the three and nine months ended September 30, 2017 compared to the same periods of 2016 was primarily attributable to our larger clients, driven by an increase in our sales and marketing activities and our improved brand awareness.

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Cost of Revenue
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Cost of revenue
 
$20,497
 
$17,790
 
$2,707
 
15%
 
$60,741
 
$51,164
 
$9,577
 
19%
% of Revenue
 
41%
 
43%
 
 
 
 
 
42%
 
43%
 
 
 
 
The increase in cost of revenue for the three and nine months ended September 30, 2017 compared to the same periods of 2016 was primarily due to a $1.6 million and a $4.7 million increase in cash-based personnel costs driven by increased headcount, a $0.7 million and a $1.6 million increase in third party hosted software costs due to increased client activities, and a $0.4 million and a $1.1 million increase in facility-related costs. For the nine months ended September 30, 2017 compared to the same period of 2016, the increase was also driven by a $1.4 million increase in data center costs, USF contributions and other federal telecommunication service fees primarily due to increased client usage.
Gross Profit
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Gross profit
 
$29,584
 
$23,192
 
$6,392
 
28%
 
$84,081
 
$66,719
 
$17,362
 
26%
% of Revenue
 
59%
 
57%
 
 
 
 
 
58%
 
57%
 
 
 
 
The increase in gross profit for the three and nine months ended September 30, 2017 compared to the same periods of 2016 was primarily due to increases in subscription and usage revenues. The increase in gross margin for the three and nine months ended September 30, 2017 compared to the same period of 2016 was primarily due to economies of scale for subscriptions and to improved efficiency in usage.
Operating Expenses
Research and Development
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Research and development
 
$6,689
 
$6,041
 
$648
 
11%
 
$20,372
 
$17,642
 
$2,730
 
15%
% of Revenue
 
13%
 
15%
 
 
 
 
 
14%
 
15%
 
 
 
 
The increase in research and development expenses for the three and nine months ended September 30, 2017 compared to the same periods of 2016 was primarily due to a $0.5 million and a $1.5 million increase in cash-based personnel-related costs resulting from increased headcount, and a $0.3 million and a $0.7 million increase in stock-based compensation costs. For the three months ended September 30, 2017 compared to the same period of 2016, the increase was partially offset by a $0.1 million decrease in consulting costs. For the nine months ended September 30, 2017 compared to the same period of 2016, the increase was also driven by a $0.3 million increase in facilities and allocated overhead costs.

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Sales and Marketing
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Sales and marketing
 
$16,502
 
$12,925
 
$3,577
 
28%
 
$49,212
 
$38,268
 
$10,944
 
29%
% of Revenue
 
33%
 
32%
 
 
 
 
 
34%
 
32%
 
 
 
 
The increase in sales and marketing expenses for the three and nine months ended September 30, 2017 compared to the same periods of 2016 was primarily due to a $1.0 million and a $4.0 million increase in cash-based personnel-related costs driven by increased headcount, a $1.1 million and a $2.8 million increase in commissions paid to sales personnel driven by the growth in sales and bookings of our solution, a $0.5 million and a $1.6 million increase in stock-based compensation costs, a $0.3 million and a $0.9 million increase in discretionary and other marketing-related expenses, and $0.2 million and a $0.7 million increase in business travel and related expenses. These increases, as well as the remainder of the increase, were primarily due to the execution of our growth strategy to acquire new clients, to increase the number of agent seats within our existing client base, and to establish brand awareness.
General and Administrative
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
General and administrative
 
$4,679
 
$6,143
 
$(1,464)
 
(24)%
 
$20,384
 
$18,561
 
$1,823
 
10%
% of Revenue
 
10%
 
15%
 
 
 
 
 
14%
 
17%
 
 
 
 
The decrease in general and administrative expenses for the three months ended September 30, 2017 compared to the same period of 2016 was primarily due to a $2.1 million reversal of interest and penalties on the accrued federal fees following a favorable ruling from the FCC's Wireline Competition Bureau. See Note 9 of the notes to condensed consolidated financial statements for more information. The decrease was offset in part by a $0.4 million increase in cash-based personnel-related costs driven by increased headcount and a $0.3 million increase in stock-based compensation costs.
The increase in general and administrative expenses for the nine months ended September 30, 2017 compared to the same period of 2016 was primarily due to a $1.8 million settlement and legal costs incurred in the first quarter of 2017, a $2.0 million increase in cash-based personnel-related costs driven by increased headcount, and a $0.8 million increase in stock-based compensation costs. The increase was offset partially by a $1.0 million decrease in facility-related cost and a $2.1 million reversal of interest and penalties on the accrued federal fees following a favorable ruling from the FCC's Wireline Competition Bureau. See Note 9 of the notes to condensed consolidated financial statements for more information.
Other Income (Expense), Net
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
September 30, 2017
 
September 30, 2016
 
$
Change
 
%
Change
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except percentages)
Extinguishment of debt
 
$

 
$
(1,026
)
 
$
1,026

 
100
%
 
$

 
$
(1,026
)
 
$
1,026

 
100
%
Interest expense
 
(865
)
 
(961
)
 
96

 
10
%
 
(2,635
)
 
(3,357
)
 
722

 
22
%
Interest income and other
 
118

 
12

 
106

 
883
%
 
326

 
(66
)
 
392

 
594
%
Total other expense, net
 
$
(747
)
 
$
(1,975
)
 
$
1,228

 
62
%
 
$
(2,309
)
 
$
(4,449
)
 
$
2,140

 
48
%
% of Revenue
 
(1
)%
 
(4
)%
 
 
 
 
 
(2
)%
 
(3
)%
 
 
 
 

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The decrease in other income (expense), net for the three and nine months ended September 30, 2017 compared to the same period of 2016 was primarily due to a $1.0 million loss on the refinancing of debt recorded in the third quarter of 2016 in connection with the repayment of amounts due under the 2013 Loan and Security Agreement and the 2014 Loan and Security Agreement. See Note 5 of the notes to condensed consolidated financial statements for more information. The decrease was also due to lower interest expense from lower interest rates under the 2016 Loan and Security Agreement, partially offset by the non-cash adjustment on investment of $0.1 million and $0.2 million for the three and nine months ended September 30, 2017.
Liquidity and Capital Resources
To date, we have financed our operations primarily through sales of our solution, lease facilities and net proceeds from our equity and debt financings. As of September 30, 2017, we had cash and cash equivalents totaling $63.4 million.
As of September 30, 2017, we had a total of $32.6 million outstanding under the New Revolving Credit Facility governed by our 2016 Loan and Security Agreement. On August 1, 2016, we entered into the 2016 Loan and Security Agreement with two lenders for the New Revolving Credit Facility of up to $50.0 million. The New Revolving Credit Facility matures on August 1, 2019. Under the terms of the New Revolving Credit Facility, the balance outstanding cannot exceed our trailing four months of MRR (monthly recurring revenue including subscription and usage) multiplied by the average trailing 12 month dollar based retention rate (calculated on the same basis as described above under the heading "Annual Dollar-Based Retention Rate"). The New Revolving Credit Facility carries a variable annual interest rate of the prime rate plus 0.50%, subject to a 0.25% increase if our adjusted EBITDA is negative at the end of any fiscal quarter. Upon the effectiveness of the 2016 Loan and Security Agreement, we immediately drew down $32.6 million and terminated the 2013 Loan and Security Agreement and the 2014 Loan and Security Agreement by repaying the aggregate outstanding principal, accrued interest and prepayment penalty balances thereunder of $32.4 million along with $0.2 million in administrative fees. As of September 30, 2017, the amount available for additional borrowings was $17.4 million.
In addition, as of September 30, 2017, we had a $0.5 million FCC civil penalty payable to the U.S. Treasury. See Note 5 of the notes to condensed consolidated financial statements for more information.
We believe our existing cash and cash equivalents and the amount available for borrowing under our New Revolving Credit Facility (or any refinancing of the facility) will be sufficient to meet our working capital and capital expenditure needs for at least the next 12 months. Our future capital requirements will depend on many factors including our growth rate, continuing market acceptance of our solution, client retention, our ability to gain new clients, the timing and extent of spending to support development efforts, the outcome of any pending or future litigation or other claims by third parties or governmental entities, the expansion of sales and marketing activities and the introduction of new and enhanced offerings. We may also acquire or invest in complementary businesses, technologies and intellectual property rights, which may increase our future capital requirements, both to pay acquisition costs and to support our combined operations. We may raise additional equity or debt financing at any time. We may not be able to raise additional equity or debt financing on terms acceptable to us or at all. If we are unable to raise additional capital when desired or required, our business, operating results, and financial condition would be harmed. In addition, if our operating performance during the next twelve months is below our expectations, our liquidity and ability to operate our business could be harmed
If we raise additional funds by issuing equity or equity-linked securities, the ownership of our existing stockholders will be diluted. If we raise additional funds through the incurrence of additional indebtedness, we will be subject to increased debt service obligations and could also be subject to new or additional restrictive covenants and other operating restrictions that could harm our ability to conduct our business.

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Cash Flows
The following table summarizes our cash flows for the periods presented (in thousands, except percentages):
 
 
Nine Months Ended
 
 
September 30, 2017
 
September 30, 2016
 
$ Change
 
% Change
Net cash provided by operating activities
 
$
8,226

 
$
4,004

 
$
4,222

 
105
 %
Net cash used in investing activities
 
(1,809
)
 
(1,033
)
 
(776
)
 
(75
)%
Net cash used in financing activities
 
(1,175
)
 
(4,122
)
 
2,947